Perestroikas Missing Ingredient

Dr. Pasour is professor of economics at North Carolina State University at Raleigh.

Perestroika, Mikhail Gorbachev’s widely discussed restructuring of the Soviet economy, has done little to improve Soviet living standards. Are the heralded perestroika reforms consistent with the increased use of mar ket forces to organize production? Is the proposed restructuring of the Soviet economy ever likely to raise living standards for the Russian people? Unfortunately, a necessary ingredient for economic coordination in a productive economy is missing in Gorbachev’s perestroika. In fact, so long as the restructuring of the economy fails to heed the lesson from the socialist calculation debate that occurred more than 50 years ago, perestroika is doomed to failure.

The Socialist Calculation Debate

In the 1920s and 1930s, Ludwig von Mises and F. A. Hayek demonstrated that successful economic planning is impossible in a centrally directed socialist economy in which market prices are necessarily absent.[1] Without market prices there is no possibility of calculating costs, no meaningful profit and loss signals, and no way to determine the goods and services most highly valued by consumers.

Decentralized markets bring about economic coordination in two ways. First, market prices coordinate and transmit information to various participants in the competitive entrepreneurial market process more completely and accurately than can be done through central direction. Indeed, Hayek showed that a great deal of economic information is highly specialized to time and place and that these data cannot be conveyed in statistical form to central planners.

Consider the land market. A tract of land may have a number of alternative uses, including housing, industry, recreation, and agricultural production. The land market is unique in its ability to channel land to different uses, taking into account the supply of land and the demands for its various uses. For example, when the demand for corn rises, producers tend to bid up the price of land that is suitable for growing corn and increase the amount of land used in corn production. Furthermore, producers need not know why the demand for corn has risen in order to take the action that is socially beneficial. The correct action occurs as profit-seeking entrepreneurs respond to price signals. No method of central direction in allocating resources can match market prices in effectively using the data held by present and prospective market participants to achieve the pattern of production most consistent with consumer preferences.

The second way that decentralized markets bring about economic coordination is through the entrepreneurial discovery process. Expected profits provide the inducement for alert entrepreneurs to become aware of profit opportunities and to search for more profitable production methods, including the development of new products.[2] A major shortcoming of all alternatives to extensive use of free markets is in the area of economic change and innovation. The lesson of the economic calculation debate is that there is no alternative to decentralized markets as a means of discovering and achieving the most productive pattern of resource use. Stated differently, a socialist economy is necessarily inefficient as a means of organizing production.

Market Socialism and the Missing ingredient in Perestroika

Despite the cogency of their argument that socialism is less productive than a market system, Mises and Hayek failed to convert the proponents of socialist planning during the 1920s and 1930s. Indeed, the issues discussed in the economic calculation debate at that time were largely forgotten as government control of the economy increased following the Great Depression and Keynesian revolution of the 1930s.

In convincing their critics of the importance of prices, Mises and Hayek inspired attempts through “market socialism” to simulate or duplicate the end results of the operation of a free market economy and to use those results to run the economy. The oxymoron “market socialism” refers to mathematical procedures developed by Oskar Lange and other economists to refute the finding by Mises and Hayek that socialism is necessarily inefficient. Using mathematical optimization techniques, it was demonstrated that a central planner, if given data on available resources, production alternatives, and consumer preferences, can determine the pattern of resource use that most fully accommodates consumer preferences for goods and services.[3]

Hayek, however, showed that this mathematical exercise has little significance for economic planning under real world conditions. In assuming that the planner is given information which can be revealed only through the operation of the market process, the market socialism approach assumes away the most important economic problem—the efficient utilization of knowledge. The required information to determine the most productive pat tern of resource use is not given to planners. Furthermore, there is no way that much of the highly specialized information relevant to economic decisions can be assembled, coordinated, and transmitted through central direction. The result is that while “market socialism” may not be logically contradictory, it is practically impossible because of information problems.

The lesson of the socialist calculation debate is that there is no way efficiently to “reform prices” in a socialist system. However, the Soviet planners appear to have learned nothing from it. In an attempt to deal with the economic crisis, Soviet Prime Minister Nikolai Ryzhkov outlined the government’s new perestroika plans in December 1989. He pledged to “reform prices” and to boost output of consumer goods, but indicated no plans to make fundamental changes in the system of government ownership and control of the economy. Consequently, it is predictable that the new perestroika plan, consisting merely of cosmetic’ reforms of the Soviet central planning system, will have little effect on the lagging economy.

The missing ingredient of perestroika is private property with decentralized markets. Mises and Hayek demonstrated that the “market socialism” goal of maintaining socialism while determining market prices through mathematical procedures is a vain hope. A socialist system cannot be organized through the market because markets without divisible and transferable property rights are a “sheer illusion.”[4] Therefore, meaningful economic reforms are ruled out so long as Gorbachev remains adamant in his resolve to search for answers to the economic crisis within socialism, as he wrote in his 1987 book Perestroika: “To put an end to all the rumors and speculations that abound in the West about this, I would like to point out once again that we are conducting all our reforms in accordance with the socialist choice. We are looking within socialism, rather than outside it, for the answers to all the questions that arise . . . . Every part of our program of perestroika . . . is fully based on the principle of more socialism. . . .”[5]

Perestroika will not bring about a significant improvement in living standards without reforms that are incompatible with socialism. Gorbachev wants the material productivity associated with a market economy, but he is unwilling to forgo socialism. Yet, the “socialist choice” is incompatible with market prices that provide the correct signals to producers and consumers in the entrepreneurial market discovery process. Consequently, little improvement will be forthcoming without the institution of private property and the associated sweeping reduction in powers of central planners that are required to overcome the current inefficient system.

Perestroika isn’t working because it is merely a reworking of the old five-year planning methods that have culminated in the current Soviet economic crisis. Gorbachev’s concept of perestroika within socialism was brilliantly satirized by Soviet economist G. K. Popov in the Soviet Congress when the new perestroika plans were announced last December. Using an example of the precise, hyperbolic predictions of seven decades of central planning, Popov memorably contrasted the Gosplan technique of ordering production to meet national goals with the decentralized approach: “This hen will produce 180 eggs this year, 183 eggs the next, then 185. Why don’t we finally leave this hen alone and let her live with her rooster? Thanking us for her independence, this hen will provide us with enough eggs.”[6]

Popov, at least implicitly, accepts the lesson from the economic calculation debate—central planning is no substitute for economic freedom as a means of determining the mix of production and of organizing production to achieve this result. The unplanned nature of the decentralized free market economy also is highly significant from an ethical standpoint. However, consideration of the moral implications of the planned economy is beyond the purview of this essay.[7]

Conclusions

Private property is the most important missing ingredient in perestroika. There is no satisfactory alternative to a widespread use of the free market, but this is incompatible with government ownership of resources. The lesson of the socialist calculation debate suggests that the attempt to solve the Soviet economic crisis by “looking within socialism, rather than outside it” will fail. Gorbachev’s perestroika plan, which holds that prices can perform their role in productively allocating resources in a collectivist economic system, is a grand illusion.

THE FREEMAN

EMAIL UPDATES

* indicates required

Email Address *

CURRENT ISSUE

December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.